Collateralization and Composability: What I learned at DeFi Summit London 2019

Building a better financial system one loan at a time

Jon Jordan
Sep 13, 2019 · 4 min read

The DeFi Summit London 2019, held at Imperial College on 10–11 September, was a microcosm of who and what’s happening in the hottest sector in blockchain.

Key players ranging from MakerDAO and ConsenSys to Centrifuge, Oasis Labs (The Oasis Team), Gnosis, Melonport (now Avantgarde Finance Ltd), and UMA were talking about the key opportunities and challenges they’re facing.

In the latter case, overcoming the friction surrounding onboarding, especially with respect to identity and legislation (KYC, AML etc) to gain real user scale, remain thorny problems for the entire space.

Anecdotal estimates from various speakers suggested DeFi’s current addressable market topped out at around 50,000 people/wallets, which is broadly similar to the estimates I’ve heard about the size of the blockchain gaming space.

Certainly it would be interesting to research how much overlap there is between the two.

Turtles all the way down

Clearly plenty of foundational blocks need to be put in place before millions of people are accessing these products, let alone ensuring Joe Lubin wins his $500,000 bet with Jimmy Song about the size of the dapp ecosystem by 2023.

Yet, this state of affairs didn’t (and shouldn’t) dampened the enthusiasm and ambition of companies in the DeFi space. Significantly the most used, new buzzword I heard during the conference was ‘composability’.

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Nothing to do with non-chemical toilets, it’s one of the fundamental advantages of the blockchain world in terms of products being built on top of products, being built on top of products, in a permissionless and transparent manner.

In contrast would the Financial Crisis have happened if institutions had been forced to write their mortgage-backed securities in open code? Maybe, but the risk levels would have been more apparent earlier.

It was no surprise in the context of composability, MakerDAO and its DAI stablecoin were most cited.

DAI can already been viewed as financial stack, with DAI being the basis for cDAI, which generates interest, and thence to rDAI, which breaks out those interest payments for other uses.

There’s now even LSDai — “earn compound interest with your rDai collateral, while providing liquidity for hedges against variable compound interest”.

If that all seems akin to the ‘casino finance’ that sparked the inspiration for Bitcoin, then keynote speaker Alex Sokolin, ConsenSys’ global finance co-head, was on hand to remind us just because we don’t understand the complexities of finance doesn’t mean such instruments aren’t very useful for some niche users, providing greater stability to the entire global economy.

And, after all, history has demonstrated better access to finance is good for everyone’s wellbeing.

Collateralize me this

Aside from such macro considerations — but not unrelated — there was also much excitement arising from MakerDAO’s forthcoming support for multi-collateralization.

This will enable assets other than ETH to be supported as collateral to create a CDP.

Companies such as Centrifuge and UMA are already looking beyond this to the opportunity to — eventually — enable any real world asset to be digitized and used as collateral in a CDP.

Of course, it’s very early days but Centrifuge’s Tinlake product has been used in five proof of concept cases to provide: invoice factoring for a freight company; real estate financing; and even collateralizing musical royalty payments via Spotify.

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Similarly, UMA has launched its Synthetic Token Builder (on Ethereum’s Rinkeby testnet), which enables anyone to create tokens that follows the price of anything that can be fed into a smart contract.

Successfully connecting ownership in the physical realm to the digital and then sticking the result onto an immutable blockchain is a process fraught with issues, though, not least reliance on oracles for underlying valuations.

Perhaps a better first step would be collateralizing blockchain-native items? That’s the subject I covered in my talk on Collateralizing Players: Why Gamers Will Be DeFi’s Breakout Audience (51% Probability).

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Given a handful of blockchain games are already demonstrating a sustained player base of thousands of daily players, and generating enough peer-to-peer trading of NFTs to make robust valuation calculations, it seems logical such items should be part of the move to multi-collateralization.

Indeed, one game — Axie Infinity — has already enabled a manual version of this, with a dozen players locking up their rare Mystics Axies in return for DAI.

A new approach

And yet, perhaps the most interesting question posed during the conference was from Oasis Labs’ CEO Luca Cosentino who pointed out all these options required the over-collateralization of loans i.e. you have to stake more value than you can take out.

This could be considered a waste of time, he said, especially when the main use case for creating a CDP is to leverage bets on the future price of crypto.

Instead, he argued, identity and reputation remain the missing elements to enable the under-collateralization loans.

Now that is a revolutionary vision which — when solved — will see DeFi fulfil its proponents’ wildest dreams.

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